Why Bad Bank May Be A Game-Changer In Sorting Out The NPA Mess

After the big bang of demonetisation, the Union budget was presented in a rather sedate manner. The economic survey, on the other hand, was a study in contrast. The document was written with a literary flourish and provocative style, which is rarely seen in the department of dismal science. It made interesting observations on important policy discussions like universal basic income, demonetisation, fiscal framework and the economic vision. It also discussed at length in chapter four, the longstanding non-performing asset (NPA) problem and posited that it’s time for a bold action like the formation of a bad bank to resolve the critical issue.

The official version of the bad bank is presented in the form of Public Sector Asset Rehabilitation Agency (PARA). The economic survey admits that all other policy actions have failed to make a substantial dent in resolving the problem and hence PARA is the last remaining recourse.

One of the biggest impediments to economic growth and job creation that the government is facing is the stagnation and slowdown in credit growth. The problem cannot be wished away, and eventually, the buck will stop at 7 Race Course Road, Delhi. To avoid mounting costs to the economy, decisive steps have to be taken promptly to resolve the problem once and for all.

As observed in other countries facing a similar problem, a large scale capitalisation programme is generally deployed to bail out the distressed parties. In this case, the government is shying away from such a step. Perhaps, the government has been unable to mobilise the required resources due to the severity and magnitude of the problem and is actively looking at alternative sources like Reserve Bank of India's (RBI) balance sheet. It may also be a matter of sequencing, in the sense that policy-makers are looking at appropriate resolution framework before carrying out large-scale recapitalisation. As hinted in the economic survey, it is likely that it is a combination of the above two factors. For now, the Rs 70,000 crore allocation provided in instalments to public sector undertaking (PSU) banks through the Indradhanush programme is helping in containing the problem but is not enough by a long stretch for a full-fledged permanent resolution.

The economic survey points out that credit rating agencies as a whole, have taken a discriminatory approach to India’s fundamentals when compared to China’s. While it is true that upgrading China’s credit rating is highly questionable given the structural headwinds the country is facing, it’s difficult to blame rating agencies for not upgrading India’s current rating of banks bureau board (BBB) – for its long-term debt. Once India resolves its twin balance sheet problem of corporations and PSU banks, the policy-makers will find that rating agencies will be much more receptive to India’s suggestions of a rating upgrade. India’s macroeconomic stability, which is witnessing a steady rise since 2013, is highly impaired due to the festering wound caused by the twin balance sheet problem.

The Good, Bad And Ugly Of The Banking System

Given the highly complex nature of the problem, it is a given that the path to implementation of PARA will not be simple at all. There will be resistance from many quarters, which will have to be smoothed out from the outset. One of the initial steps that will have to be taken is the segregation of loans into different categories. Broadly, the loans will have to be categorised under the following:

Category A: Loans to companies, which have a high capacity of servicing it

Category B: Loans to companies, which do not have the capacity to service it unless there is a further capital infusion through debt, equity or a combination of both. Partial debt relaxation can also be looked at in certain cases if underlying fundamentals of the company is sound enough to not require further infusion

Category C: Loans to companies, which do not have the capacity to repay loans and service interest even after further capital infusion or partial debt relaxation

Since the above categorisation will involve a high degree of subjectivity, it is necessary to have extremely capable and credible people making these decisions and handling such discretionary powers. The BBB and the governing body of PARA would be ideal participants in undertaking such an exercise under the watchful eyes of RBI. The chances of successful resolution get better when both PSU banks and PARA co-ordinate in categorising the loans. One of the major objectives of forming PARA would be to rid PSU banks of Category C loans so that its financial health can be restored through further recapitalisation. Only then would PSU banks be capable of running its lending operations at full potential.

The responsibility of dealing with Category C loans would solely rest with PARA which can then take appropriate measures to liquidate the assets through auctions and recover the loan amount as much as possible. It also helps matters that the Insolvency and Bankruptcy Code has been passed to ensure time-bound resolution of insolvency cases. PARA would have to work in tandem with insolvency professionals agencies (IPA) and information utilities (IU) to streamline insolvency resolution. PARA may also have to tap external funding sources like stressed assets funds, both domestic and international, to build a sufficient bankroll and capital reserves.

Given the critical role of credit growth in economic expansion as well as job creation, it is high time that conclusive steps are taken at the earliest to resolve the festering twin balance sheet problem. Solutions like forbearance, restructuring of stressed assets and limited recapitalisation of PSU banks have not been enough to ensure a permanent resolution. Establishment of PARA may well turn out to be the game-changing decision that is required at this juncture. Former RBI governor Raghuram Rajan did suggest that a deep surgery is necessary to solve the NPA crisis. PARA may just be what the doctor ordered, if implemented properly and with conviction.